“From an equity market perspective, all classic signs of a bubble are out there,” he said.
He warned that the amount of money that inexperienced and first-time investors are borrowing on margin to buy stocks is uncomfortably high.
“The margin debt in China as a share of its stock market is higher than during any economic bubble in recent history, including that of the US in 2000 and 2007.”
In January, regulators stopped some brokerages from lending money and stocks to new clients for three months.
About four years ago, mainland investors were not permitted to borrow on margin to invest in China’s markets, Sharma added.
Disproportionate growth
Stocks and the economy are telling two different stories, Sharma said. In the trailing 12 months, the Shanghai Stock Exchange Composite and the Shenzhen Stock Exchange Composite have surged by 135.8% and 164.5%, respectively.
Yet China’s economic slowdown is continuing. GDP grew at the slowest annual rate in 24 years last year (7.4%), while first quarter growth was 7%.
In most countries, with China the exception, there is typically a clear relationship between economic growth and stock market performance, he said.
“The Chinese equity market and its economy have long been known to be distant cousins with no relation to each other. That relationship has become even more skewed in the last year.”
He believes the equity markets are seen by authorities as a tool to support the economy. As markets heat up, companies can readily raise capital to pay off corporate debt.
“This is a new experiment that China is carrying out. Since the credit markets are clogged, they want companies to recapitalise themselves and raise equity. I would not take the Chinese equity market as a signal of what is happening in the underlying economy.”
Since November, China’s central bank has cut both interest rates and banks’ cash reserve ratio three times each, hoping to combat a slowdown in GDP growth.
The firm maintains an underweight position on China.
